When Rick Ferri, financial advisor and founder of Ferri Investment Solutions, recently saw a new client’s portfolio, it conjured up a familiar image: a comic by retirement planner Aaron Brask featuring Humpty Dumpty.
In it, an intact egg lying on the wall is labeled as an overall market category with a expense ratio is 0.04%. Appears an evil financial planner who pushed Humpty off the wall. As he puts it together, Humpty is now made up of several types of investments rather than one fund.
The advisor, currently labeling the egg as a “diversified portfolio,” is charging 1%.
It may not be the funniest comic in the world, but it’s worth paying attention to, especially if you work with a financial advisor. What the comic depicts and what Ferri sees in a client’s portfolio is all too common in the financial planning world: advisors justify the high fees by making simple strategies simple becomes complex.
“Complexity is a guarantee for mentoring,” Ferri tells CNBC Make It. “You can’t use too little money because customers will realize they don’t need you anymore.”
Here’s how to know if you’re in the “Humpty Dumpty portfolio” and why it’s essential to keep your investment costs as low as possible.
What is a ‘Humpty Dumpty Portfolio’?
In general, financial professionals will recommend investing in a low-cost and widely diversified portfolio. An easy way to achieve this is to invest in mutual fund index or exchange-traded fundseeks to track and compare the performance of a market benchmark, such as the S&P 500.
For example, if you purchased a so-called “total market” ETF, you would be exposed to a portfolio that represents the entire investable U.S. stock market. Vanguard charges an annual fee of only 0.03% for its instance.
For someone who holds both stocks and bonds, you can build a fully diversified portfolio using four funds, says Ferri: one for U.S. stocks, one for international stocks, one for US bonds and one for international bonds. “You can even get away with a sum or two,” he says.
However, in his consulting work, when fellow advisors ask for Ferri’s help in building a model portfolio, they rarely want to keep things that simple. “My first question was, ‘What’s the minimum amount?'” he said. A common answer among advisors: “At least eight. No more than 12.”
Those are names enough that when an investor looks at a portfolio, they think they have a complicated strategy. In fact, a large part of the market is often broken down into many small pieces. Put those pieces together (with or without the help of all the king’s horses) and you’ll be exposed to the same broad market indices, just for a higher price.
Total stock market funds can be divided into two camps: growth stocks and value stocks. Or you can split it up three ways: small, midsize, and large company stocks. Using just those two parameters, you could take a diversified index fund and split it into six smaller funds. Overall, your exposure to the market could be exactly the same — it just seems more complicated.
The best way to tell if you’re in such a portfolio is if you’re essentially holding two “halves” of the same index, says Ferri. “If you see big growth and great value, and have the same amount in both funds, then you know it’s BS,” he said.
Why You Don’t Want a ‘Humpty Dumpty Portfolio’
If you’re holding a ‘Humpty Dumpty portfolio’, you’re probably still doing a lot of the right things and have the ability to diversify widely across a range of low-cost investments.
And while there’s nothing wrong with paying to reduce the investment burden on others, consider how much you might have to pay.
Many advisors who manage clients’ investments charge an annual fee of 1% of the client’s investment assets. That may not seem like much now, but remember: every dollar you pay in fees is the amount that can be compounded with your investments. Over the course of your life as an investor, that can add up.
Let’s say you put $10,000 in a total stock ETF that charges 0.03% annual expense and earns 7% annual return. After 45 years, your fund will be worth more than $207,000, with you paying a total of $908 in fees.
Now, imagine you earn the same return on the same investment, but pay 1% fees. At the end of your 45 years, you’ll have $134,000 less, after having passed over $22,000 to your advisor. That doesn’t even count the fees your holdings will charge you.
That is not to say that advisors cannot provide valuable investment guidance. But weigh your options before giving a percentage of your money to someone who is replicating strategies you can create yourself.
One solution: Find a planner willing to view your portfolio for a one-time fee. “Maybe you just want to talk to an expert to make sure you don’t go astray,” says Ferri.
Or consider an advisor that offers a monthly subscription model. “Sometimes you just need some validation,” says Ferri. “It might be worth paying a fixed amount each month so you can have someone ready to help when you need it.”
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